YSSA’s Value Investing Thought Leadership Group presents
NYSSA Author Series™:
Monday August 22, 2016 6:00 PM through 8:00 PM NYSSA Conference Center
Available as: Live Session Categories: Market Integrity, NYSSA Author Series™, Programs for Members, Seminar, Value Investing
Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations” is a must-read exploration of the deep value investment strategy, describing the evolution of the theories of valuation and shareholder activism from Graham to Icahn and beyond. The book combines engaging anecdotes with industry research to illustrate the principles and methods of this complex strategy and explains the reasoning behind seemingly incomprehensible activist maneuvers. Written by an active value investor, Deep Value provides an insider’s perspective on shareholder activist strategies in a format accessible to both professional investors and laypeople.
The Deep Value investment philosophy described by Graham is rarely available in the modern market, forcing activists to adapt. Current activists exploit a much wider range of tools to achieve their goals. Deep Value enumerates and expands upon the strategies available to value investors today and describes how the economic climate is allowing value investing to re-emerge.
This event will cover:
Strategies and tactics of effective activism
Unseating management and fomenting change
Determining advantageous strategies
Eyeing conditions for the next M&A boom
Who should attend?
Portfolio Managers and Analysts
Tobias Carlisle is the founder and managing director of Carbon Beach Asset Management LLC. He is best known as the author of the well regarded website Greenbackd, the book Deep Value: Why Activists Investors and Other Contrarians Battle for Control of Losing Corporations (2014, Wiley Finance), and Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (2012, Wiley Finance). He has extensive experience in investment management, business valuation, public company corporate governance, and corporate law. Prior to founding Eyquem in 2010, Tobias was an analyst at an activist hedge fund, general counsel of a company listed on the Australian Stock Exchange, and a corporate advisory lawyer. As a lawyer specializing in mergers and acquisitions he has advised on transactions across a variety of industries in the United States, the United Kingdom, China, Australia, Singapore, Bermuda, Papua New Guinea, New Zealand, and Guam. He is a graduate of the University of Queensland in Australia with degrees in Law (2001) and Business (Management) (1999).
NYSSA expects all attendees to comply with NYSSA’s Code of Conduct while attending NYSSA events or meetings. NYSSA expressly reserves the right, in its sole discretion, to grant or deny access to any individual, or to expel any individual from any NYSSA event or meeting.
New York University’s School of Professional Studies is offering an online class focused on the time-honored techniques of value investing, as practiced by the world’s most legendary investor, Warren Buffett. We thought you might be interested in knowing more about this class, and perhaps in sharing this information with your readers.
By examining case studies of Buffett’s acquisitions, students will explore the real-world principles that Buffett uses to pick companies. The class starts April 2nd and is open to the public for registration.
For more information, please see the attached press release.
John Chew (Editor, csinvesting.org) I am not endorsing this class per se because I don’t know the professor or the details of the course material, but for those of you who seek a more structured learning experience then perhaps this class is for you. Let me know if you take the class, so I can share your experience with others. Also, remember that if you use the search box at csinvesting.org, you can find dozens of Buffett case studies for FREE.
Just remember that trying to copy Buffett will NOT work, but applying the Buffett principles of investing to YOUR OWN methodology will help you. Be the BEST YOU can be not a second-rate copy of another.
he following quote from C. Edward Griffin tells the little known story how dollars are created.
The Mandrake Mechanism
The American dollar has no intrinsic value. It is a classic example of fiat money with no limit to the quantity that can be produced. Its primary value lies in the willingness of people to accept it and, to that end, legal tender laws require them to do so. It is true that our money is created out of nothing, but it is more accurate to say that it is based upon debt. In one sense, therefore, our money is created out of less than nothing. The entire money supply would vanish into bank vaults and computer chips if all debts are repaid. Under the present System, therefore, our leaders cannot allow a serious reduction in either the national or consumer debt. Charging interest on pretended loans is usury, and that has become institutionalized under the Federal Reserve System. The Mandrake Mechanism by which the Fed converts debt into money may seem complicated at first, but it is simple if one remembers that the process is not intended to be logical but to confuse and deceive. The end product of the Mechanism is artificial expansion of the money supply, which is the root cause of the hidden tax called inflation. The expansion then leads to contraction and, together, they produce the destructive boom-bust cycle that has plagued mankind throughout history wherever fiat money has existed.
The Santangel’s Investor Forum invites eligible students to apply to receive a free ticket to attend the 2015 Forum, to be held in New York City on October 22, 2015.
A benefactor who wishes to remain anonymous has endowed a table at the upcoming conference to enable a select number of talented students to attend the annual invitation-only event.
All enrolled undergraduate and graduate students are eligible. Interested candidates should apply by emailing their resume and a current investment idea write-up to Steven Friedman (email@example.com). The idea can be for any type of security or asset class, but the write-up must be limited to 300 words. Preference will be given to unique and original ideas. Please submit ideas by September 15, 2015.
Please feel free to pass this along to anyone who may have an interest.
We skip Chapter Six (for now) and focus on Chapter 7 in DEEP VALUE: Catch a Falling Knife: The Anatomy of a Contrarian Value Strategy
In Search of Un-Excellence
The authors identified 36 publicly traded “excellent companies” on the basis of out-performance in six criteria, measured from 1961 to 1980.
Return on total capital
Return on equity
Return on sales
Market to book value
Then an investment analysts, Michelle Clayman, identified 39 publicly traded “un-excellent companies” which ranked in the bottom third of all Peters and Waterman’s criteria from 1976 to 1980. These “in search of disaster” companies outperformed 24.4% pa over five years vs. 12.7% for the “excellent” companies.
The good companies under-perform because the market overestimates their future growth and future return on equity and, as a result, accords the stocks overvalued price-to-book ratios; the converse is true of the poor companies.
Over time, company results have a tendency to regress to the mean as underlying economic forces attract new entrants to attractive markets and encourage participants to leave low-return businesses. Because of this tendency, companies that have been good performers in the past may prove to be inferior investments, while poor companies frequently provide superior investment returns in the future.”
Note pages 128 to 136 in DEEP VALUE: Tables 7.1 to 7.9
Stocks in the Contrarian Value portfolios were cheaper than the comparable Glamour portfolios on every metric but on a Price-to-Earnings basis, possibly because the earnings in those portfolios were so weak.
First, valuation is more important than growth in constructing portfolios.
Cheap, low growth portfolios systematically outperform expensive, high-growth portfolios, and by wide margins. It seems that the uglier the stock, the better the return, even when the valuations are comparable. Oppenheimer found in a study on Ben Graham Net/Nets that loss making and non-dividend paying net/nets outperform profitable, dividend-paying net/nets. Ben Graham Net Current Asset Values A Performance Update
In almost any study, the cheap, hated, ugly, least-admired, and poorly performing stock outperforms the high-growth, glamour stocks.
What these studies demonstrate is that mean reversion is a pervasive phenomenon, and one that we don’t intuitively recognize. Our untrained instinct is to pursue the glamorous stock, the high-growth stock, the story stock, the excellent stock, the admired stock, the A+ stock, or even the profitable net net, but study after study shows that this instinct leads us to under-perform. Buying well-run companies with good businesses at bargain prices seems to make even more sense. The research shows , however, that the better investment–rather than the better company–the value stock, the scorned, the unexcellent, the Ds, the loss-making net nets. And the better value stock, according to Lakonishok, Shleifer, and Vishny’s research is the low-no-growth value stock, what they describe as “contrarian value,”
What is clear is that value investing in general, and deep value (buying the ugliest of ugly) in particular, is exceedingly behaviorally difficult. It is counter-intuitive and against instinct, which is why many investors shy away from it.
Lecture by Toby Carlisle on Deep Value Investing
We will finish up this chapter by covering The Broken-Leg Problem. Please give this chapter a close study–the conclusions are extremely COUNTER-INTUITIVE and the opposite of what most investors look for. We are at the heart of deep value investing.
When everything is coming your way, you’re in the wrong lane. –S. Wright
Above you can see Seaboard’s stock price vs. Berkshire’s over the past decade.
Below is a good example of research on a cyclical company. Note that the analyst goes back far enough to see how the business performs over several cycles and economic booms and busts. You may not agree with his conclusions (say that the company will continue to grow at 12%) but you can clearly see his assumptions.
If readers in the Deep-Value group (Google Groups) find interesting case studies don’t hesitate to share with the group. You will learn more from each other than from just reading this blog or the blogs listed below.
I couldn’t repair your brakes, so I made your horn louder. –Steven Wright
A Reader shares good news.
Partly motivated by your blog and lectures on value investing, I decided to quit my dead-end Hedge Fund job, and open my own investment management firm, Apatheia Capital. Think Schloss, and early Greenblatt special situations.I intend to use the best from quant and value investing in terms of buying cheap special situation stocks consistently.
So far it has been fun, exciting and anxiety-ridden process, and few friends and family have been misguided to be infected by my optimism. Please keep up the good work! I cannot stop thinking about my ideas (about ever-present fat tails in special situation value stocks). So far in the process, I have filed for state registrations etc. and finalized a mission document for the firm.
I wish you a great journey. Be flexible and patient. Use your small size to your advantage by going anywhere there is value. Keep good records of your investment journey and keep in touch!
The Relation Between The Enterprise Multiple and Avg Stock Returns 2010 more research on the efficacy of using the enterprise multiple as an indicator of value. Remember to adjust for normalization because at the top of a cycle you will see low EV to EBITDA (like in housing circa 2005/06) or high EV/EBITDA (11 x) BTU VL Dec 2014 near a depressed cycle. Coal reserves are priced low and production doesn’t generate high enough cash flows for the industry to generate a normal return, so mines are being closed, production shuttered, mines consolidated. The cure for low prices is low prices.
Why can’t 70% of professional money managers beat chimps?
High fees/costs, index hugging, inconsistency, overconfidence in their ability to be above average, lovers of stories, herding, and the institutional imperative? Don’t forget incentives that differ from achieving performance like asset gathering. See the case study at the end of this post.
We left off with a reader asking why do money managers do better or follow a deep value approach? http://wp.me/p2OaYY-2IZ
One goal of our Deep Value journey is to find a method that suits us. This method should have a large base case rate of beating an index over a long period of time, say fifty years. The lesson learned so far—I hope—is that CHEAPNESS wins whether that is price to book value, price to sales, price to cash flow. My recent reading of the most recent 4th Edition of What Works on Wall Street shows that high EBITDA-to-EV has beaten out Price-to-Sales (3rd Edition) What Works on Wall Street, Third Edition as the best metric as a value factor. However, combined with quality of earnings metrics, it performs even better or about 18% to 19% per year since 1964 to 2009. Our goal is to put the odds on our side and CONSISTENTLY play the odds through thick and thin. Our other edge is to realize how flawed our thinking is and thus we build protection against ourselves by developing a disciplined approach.
What Works: Notes from Joel Greenblatt’s class 2002:
Read: What Works on Wall Street by James P O’Shaughnessy. He started a fund in 1996-1997 but he underperformed the market by 25% and after three years in business of underperforming he sold his company at the bottom of the cycle. The guy who wrote the book quit his system! It seems like it is easy to do, but it is not easy to do.
This book, What Works on Wall Street, has born out its wisdom. The two funds that are patented that follow his strategy have been phenomenal. HFCGX is the patented fund based on his top idea of Cornerstone Growth; over the last 5 years it has had an average return of 13.44% per year vs. the Vanguard 500’s -2.01% per year (6/1/00 through 5/31/05). HFCVX is the patented fund based on his 2nd to best idea of Cornerstone Value; over the last 5 years it has had an average return of 6.47% per year vs. the Vanguard 500’s -2.01% per year (6/1/00 through 5/31/05).
The most interesting point is that the author points out those investors often are too emotionally involved to have the discipline to see the strategy through. Not only did the first reviewer bash the book because he did like the returns strategy JUST one year after the book came out, but Mr. O’Shaughnessy sold the funds to Hennessy Funds at the end of 1999 after it failed to surpass the returns of the bubble that soon after collapsed. Seven years after it was published an investor would be much wealthier had they followed the books top strategy instead of the investors who dog-piled onto the stocks of the market’s bubble.
We are going to try to understand why it works. Why it has to work over time. That is the only way you can stick it out. The math never changes: 2 + 2 = 4. That is the level of your understanding I want you to have by the time we are done. If I get that right, forget all this other stuff and noise, I will get my money. No genius required. Concepts will make you great and your ability to STICK IT OUT.
There is a lot of experience involved in valuation work, but it doesn’t take a genius or high IQ points to know the basic concepts. The basic concepts are what will make you the money in the long run. We are all capable of doing the valuation work.
Notes from the 4th Edition of What Works on Wall Street
Why Indexing Works
Indexing works because it sidesteps flawed decision-making and automates the simple strategy of buying the big stocks that make up the S&P 500. The mighty S&P 500 consistently beat 70 percent of traditionally managed funds over the long-term by doing nothing more than making a disciplined bet on large capitalization stocks.
Money Management Performance
Past records of most traditional mangers cannot be predictive of future returns because their behavior is inconsistent. You can’t make forecasts based on inconsistent behavior.
Common Sense Prevails
We now have the ability to empirically compare different investment strategies and their ongoing performance over time. What you will see in coming chapters is that almost all of them are deeply consistent with what common sense would tell you was true. Strategies that buy stocks that are selling at deep discounts to cash flow, sales, earnings , EBITDA-to-enterprise value (Yeah, but don’t forget MCX), and so on do extraordinary better than those that are willing to buy stocks with the richest valuation. WE will be sensitive to data mining.
Systematic, structured investing is a hybrid of active and passive management that automated the buy and sell decisions. If a stock meets a particular criteria, it’s bought. If not, not. No personal, emotional judgments enter into the process. Essentially, you are indexing a portfolio to a specific investment strategy and, by doing so, uniting the best of active and passive investing. The disciplined implementation of active strategies is the key to performance. Traditional managers usually follow a hit-and-miss approach to investing. Their lack of discipline accounts for their inability to beat simple approaches that never vary from the underlying strategy.
The ONE thing that unites the best money managers is consistency.
Successful investing requires, at a minimum, a structured decision-making process that can be easily defined and a stated investment philosophy that is consistently applied.
Goeth said, “In the realm of ideas everything depends on enthusiasm; in the real world, all rests on perseverance.” While we may intellectually understand what we should do, we usually are overwhelmed by our nature, allowing the intensely emotional present to overpower our better judgment.
Human Judgment is limited
Why models beat humans
Models beat the human forecasters because they reliably and consistently apply the same criteria time after time. It is the total reliability of application of the model that accounts for its superior performance.
We are ALL above average.
Base rates are boring
We prefer gut reactions and stories to boring base rates.
Stocks with low PE ratios outperformed the market in 99 percent of all rolling 10-year periods between 1964 and 2009.
The best way to predict the future is to bet with the base rate that is derived from a large sample.
Base rates are boring while experience is vivid and fun. Never mind that stocks with high P/E ratios beat the market less than 1 percent of the time over all rolling 10-year periods between 1964 and 2009.
Montier in his book, Value Investing writes: “One of the recurring themes of my research is that we just can’t forecast There isn’t a shred of evidence to suggest that we can.
We prefer the complex and artificial to the simple and unadorned.
Nowhere does history indulge in repetition so often or so uniformly as in Wall Street. When you read contemporary accounts of booms or panics, the one thing that strikes you most forcibly is how little either stock speculation or stock speculators today differ from yesterday. The game does not change and neither does human nature.—Edwin Lefevre.
Because of the interrelated nature of the emotional and rational centers of our brain, we will never be able to fully overcome our tendency to make irrational choices. Simply being aware of this problem does not make it go away. To break from our human tendencies to chase performance and perceive patterns where there are none, we must find an investment strategy that removes subjective, human decision-making from the process and relies instead on smart, empirically proven systematic strategies. We can become wise by realizing how unwise we truly are.
Rules of the Game
It is amazing to reflect how little systematic knowledge Wall Street has to draw upon as regards the historical behavior of securities with defined characteristics. –Ben Graham
Richard Brealey, a respected data analysis, estimated that to make reasonable assumptions about a strategy’s validity (95% confidence level or statistically relevant) you would need 25 years of data.
Short periods are valueless
Consider the “soaring sixties” when the go-go growth managers of that era switched stocks so fast that they were called gunslingers. The go-go investors of the era focused on the most rapidly growing companies without even considering how much they were paying for every dollar of growth. Between Jan 1, 1964, and Dec. 31, 1968, $10,000 invested in a portfolio that annually bought the 50 stocks in the Compustat data base with the best annual growth in sales soared to $33,000 in value , a compound return of 27.34 % a year. That more than doubled the S&P 500’s 10.16% annual return, which saw $10,000 grow to just $16,200. Unfortunately, the strategy went on to lose 15.7% per year for the following five years compared to a gain of two percent for the S&P 500.
Had this same hapless investor had access to long-term returns, he would have seen that buying stocks based just on their annual growth of sales was a horrible way to invest—the strategy returns just 3.88 percent per year between 1964 and 2009. Of course, the investor received similar results if he repeated the experiment between 1995 and 1999 and then the next five years.
EBITDA to EV was the best on an absolute basis for all the individual value factors we examine from 1964 to 2009 such as price to cash flow, price to earnings, etc.
EV/EBITDA in the lowest decile (the most EBITDA per EV) generated a 16.58% CAGR vs. 11.22% for the All Stocks universe with a standard deviation of returns of 17.71 percent, more than 1 percent below that of All stocks, 18.99 percent. The worst five-year period for the metric was 2000 during the Internet Mania. These ups and downs for a strategy are all part of the bargain you must strike with yourself as a strategic investor. Pages 103 to 124 in What Works (4th Ed.) The EV/EBITDA in the highest decile (the most “expensive) did the worst of all the value metrics studied!
EV works well as a guide to under-and-over valuation when contrasted to EBITDA, SALES, and Free cash flow.
Price to book value ratios are a long-term winner with LONG periods of underperformance.
Accounting Ratios can help identify higher quality earnings:
Total accruals to total assets
Percentage change in net operating assets (NOA)
Total accruals to average asses.
Depreciation expense to capital expense.
We are looking for stocks with high earnings quality.
Accounting variables mater. How companies account for accruals, how quickly they depreciate capital expenses and their additions to debt all have a serious impact on the health of their stock price.
Successful investing relies heavily on buying stocks that have good prospects, but for which investors currently have low expectations. Stocks with great earnings gains and high net profit margins are basically high expectations stocks.
History shows that using high profit margins as the SOLE determinant for buying a stock leads to disappointing results. The only lesson here is that it is best to avoid stocks with the lowest net profit margins.
A Case Study in Why Money Managers Lose Even With a Winning Hand
Winning Stock Picker’s Losing Fund
Value Line Research Service Has Beaten Market Handily, But Its Own Fund Suffered By Jeff D. Opdyke and Jane J. Kim Staff Reporters of THE WALL STREET JOURNAL Updated Sept. 16, 2004 12:01 a.m. ET
Value Line Investment Survey is one of the top independent stock-research services, touted for its remarkable record of identifying winners. Warren Buffett and Peter Lynch, among other professional investors, laud its system.
But the company also runs a mutual fund, and in one of Wall Street’s odder paradoxes, it has performed terribly. Investors following the Value Line approach to buying and selling stocks would have racked up cumulative gains of nearly 76% over the five years ended in December, according to the investment-research firm. That period includes the worst bear market in a generation.
Why the Fund Lagged
Past managers bought stocks that in some cases were well below the company’s top-rated choices, hurting performance.
Style drift: The fund has swung among small-, mid- and large-cap shares.
High turnover of fund managers meant little consistent investment discipline.
By contrast, the mutual fund — one of the nation’s oldest, having started in 1950 — lost a cumulative 19% over the same five years. The discrepancy has a lot to do with the fact that the Value Line fund, despite its name, hasn’t rigorously followed the weekly investment advice printed by its parent Value Line Publishing Inc. It also highlights the penalty investors often face when their mutual fund churns its management team and plays around with its investing style. In fact, late last night the person running the fund, Jack Dempsey, said that as of yesterday he had been reassigned and no longer had responsibility for managing the assets. Value Line couldn’t be reached to comment.
Most of all, the discrepancy between the performance of the fund and the stocks it touts shows that investors don’t always get what they think they’re buying in a mutual fund. For even though Value Line’s success is built around stocks ranked No. 1 by the company’s research arm, the fund’s managers have in recent years dipped into stocks rated as low as No. 3.
Ironically, even while Value Line’s own fund struggles to match the Value Line Investment Survey’s success, an independent fund company that licenses the Value Line name is doing much better with Value Line’s investment approach.
The First Trust Value Line 100 closed-end fund, run by Lisle, Ill.,-based First Trust Portfolios, adheres far more rigorously to Value Line’s investment principles, owning only the top-rated stocks.
Each Friday, First Trust managers log on to the Value Line site to download the week’s list of Value Line’s 100 most-timely stocks. During the next week, they sell the stocks that have fallen off the list and buy those that have been added. The result: Since its inception in June 2003, the First Trust Value Line fund’s net-asset value is up 12.4%, slightly better than the 11.6% gain the Standard & Poor’s 500-stock index posted in the same period.
Value Line’s own fund, meanwhile, gained 3.1% in that same time. Because the fund has been such a laggard in recent years, investors have been walking away. Assets in the fund — in the $500 million range as recently as 1999 — are now less than $200 million, though some of that stems from market losses.
Part of the underperformance stems from previous fund managers who didn’t rely entirely on Value Line’s proven model, opting instead to venture into lower-rated stocks, betting that active fund managers could unearth overlooked gems that one day would shine as top-rated stocks. Thus, investors who thought they were buying into Value Line’s winning investment strategy instead were buying into fund managers who thought they could outperform by second-guessing the company’s research — a tactic that didn’t work well.
Because the fund wasn’t performing well, the company changed managers frequently, searching for one who could post winning returns.
Value Line appeared to be moving back toward its roots in March, when it put Mr. Dempsey in charge of the fund. He isn’t the traditional mutual-fund manager; he’s a computer programmer who for a decade helped refine Value Line’s investment models. Value Line, which uses a team-managed approach, has had at least five lead fund managers since 1998, including Mr. Dempsey, according to Morningstar.
In an interview prior to his reassignment, Mr. Dempsey said he had been restructuring the fund to follow the ranking system “in a much more stringent fashion.” Today, about 95% of the stocks in the fund are rated No. 1. Mr. Dempsey said his goal was to liquidate within a week stocks that fell below Value Line’s No. 1 ranking.
The Value Line survey produces independent research on Wall Street stocks. The weekly view of 1,700 stocks, which costs $538 a year online (www.valueline.com) and nearly $600 in print form, is particularly popular with do-it-yourself investors and the abundance of investment clubs in the U.S. Value Line rates stocks in a variety of ways, but is especially known for its so-called timeliness rank. Stocks ranked No. 1 are timely and expected to outperform the market; those ranked No. 5 are expected to lag.
Instead of running an actively managed fund in which a manager cherry-picks the stocks the fund owns, Value Line could operate what amounts to an index fund that simply owns the highest-ranked stocks in the survey. However, active managers believe they can improve the performance of a fund.
“As a fund manager, you want to add value,” Mr. Dempsey said. Still, he acknowledged that “it’s hard to beat our quantitative system.” In the short time that Mr. Dempsey was in charge — a nearly six-month period in which he transformed the portfolio — he accumulated losses of about 2%, compared with losses of 0.2% at the S&P 500. However, he topped the First Trust fund, which is down about 2.5% in the same period. Under Mr. Dempsey, the fund accumulated significant positions in stocks such as Research In Motion Ltd. and added new positions in Yahoo Inc. and Arrow Electronics Inc., among other companies, according to Morningstar.
Value Line, based in New York, doesn’t detail the inner workings of its proprietary stock-picking model. By and large, though, the strategy is built around stocks displaying price and earnings momentum and posting earnings surprises, says John James, chairman of the Oak Group, a Chicago company that runs hedge funds, some of which try to anticipate changes in Value Line’s stock rankings and then invest based on which stocks will rise to No. 1 from No. 2.
However Value Line’s model works, there’s no question the company’s research produces winning choices. Value Line’s list of stocks ranked No. 1 produced cumulative gains of nearly 1,300% from Dec. 31, 1988 through June, 30, 2004, according to Value Line. The S&P 500, by comparison, posted cumulative gains of 311%.